The British pound crashed to a record low last fall as investors rebelled against budget plans by former Prime Minister Liz Truss. Now, it’s enjoying a comeback.
Sterling hit its highest level against the US dollar in 10 months on Tuesday, topping $1.25 for the first time since June 2022. The pound, which has advanced about 3.3% versus the greenback since the start of 2023, is the best-performing currency among developed economies this year.
The UK currency has been boosted by indications the country’s economy is holding up better than expected. Activity is now thought to have expanded 0.1% in the final three months of last year, up from a previous estimate of no growth at all. Gross domestic product growth in January has been estimated at 0.3% after dropping 0.5% in December.
This resilience is bolstering expectations the Bank of England will maintain aggressive interest rate hikes despite concerns about the health of the global banking sector. Rising rates can boost the domestic currency because they help attract foreign investors searching for higher returns.
Inflation in the United Kingdom also jumped to an annual rate of 10.4% in February, underscoring the need for the Bank of England to maintain its tough approach.
The pound turnaround
The pound plunged close to $1.03 in September 2022 after the Truss government unveiled plans to boost borrowing while slashing taxes, unleashing panic in financial markets that fueled fears of a recession in the United Kingdom.
The International Monetary Fund predicted in January that the UK economy would contract by 0.6% this year, while all other advanced economies would grow, if only slightly.
“There was a lot of pessimism being priced into the pound,” said Francesco Pesole, a currency strategist at ING.
But the sharp pullback in energy prices and China’s reopening have provided some relief about the economic outlook since the start of the year.
“There was a big re-rating of growth expectations around Europe, and that impacted the UK,” Pesole said.
The euro has also been lifted by these dynamics, rising 2.3% against the US dollar in 2023. The pound’s rally has been sharper in large part because its 2022 declines were more severe, according to Pesole.
Both currencies have been aided by the greenback’s sharp drop from highs reached last September as recession fears have percolated in the United States.
A lack of clarity around the Federal Reserve’s next steps has also restrained the dollar in recent weeks. Investor speculation has increased that the Fed could pause or stop rate hikes due to concerns about the economy following the failure of Silicon Valley Bank last month.
Jordan Rochester, a currency strategist at Nomura, said he thinks the pound could rise to $1.30 this year and “potentially higher.” But he still sees risks given the uncertainty surrounding the Bank of England’s plans and how rate rises will feed back through the country’s economy. And Pesole cautioned that currency fluctuations are often overdone when markets are choppy, as they are now.
“In a volatile market environment, moves are exacerbated,” he said.